John from Illinois has $4.6 million saved, a pension that pays $9,500 a month, and a clear goal: give each of his three children $125,000 a year over three years to help them buy homes. He believes he will owe 30% FICA tax on every 401(k) dollar he withdraws. That belief is wrong, and correcting it could save him tens of thousands of dollars in unnecessary tax anxiety and poor timing decisions.
The Tax He’s Paying Is Not What He Thinks It Is
FICA (Federal Insurance Contributions Act) taxes fund Social Security and Medicare. They apply to earned income: wages and self-employment income. 401(k) withdrawals are not subject to FICA taxes. Once John retires, he will owe no Social Security or Medicare tax on retirement account withdrawals. What he will owe is ordinary federal income tax, and at his income level, that distinction matters enormously.
Clark Howard acknowledged John’s fortunate position on the podcast, noting that “it is so hard to buy a house” and that even someone who is “30 and making a great living” still struggles as a first-time buyer. That context is real. But the tax framing John used deserves a correction before he makes any withdrawal decisions.
John mentions he is currently in the 35% tax bracket and plans to pay off his $350,000 mortgage once he drops out of it after retirement. His current taxable income is above $512,450 for married filing jointly, the 2026 threshold where the 35% bracket begins. His pension alone will pay $9,500 a month, or $114,000 annually, well below that threshold. His tax rate in retirement will almost certainly be lower than today, and the gap between those two rates is where his planning opportunity lives.
What the Withdrawal Math Actually Looks Like
John’s plan is to withdraw $125,000 per year for three years per year for three years to fund the gifts, and the timing of those withdrawals is the central planning question. If he waits until retirement, his pension becomes the income baseline, and layering the 401(k) withdrawal on top of that still keeps him in a lower federal bracket than he occupies today — specifically the 32% bracket rather than the 35% bracket he is in today. Waiting until retirement to make those withdrawals, rather than pulling them while still earning a full salary, is where the tax savings are found.
If he makes those same withdrawals while still working in the 35% bracket, he pays more on every dollar. Waiting until retirement would result in a lower marginal rate on those withdrawals based on the bracket math.
The Gift Tax Angle He May Be Overlooking
Receiving a gift does not create a tax liability for John’s children. The gift tax, if it applies at all, falls on the giver. Because John is married, he and his spouse can combine their annual exclusions to give $38,000 per child per year without touching the lifetime exemption at all. Across three children, that covers $114,000 per year in completely exclusion-sheltered gifts before any reporting is required.
The remaining $11,000 per year above that threshold simply reduces his lifetime gift and estate tax exemption, which currently sits at $15,000,000 per person under current law. Given his asset level, this is not a practical concern. John is not facing a gift tax problem. He is facing an income tax problem on the withdrawal itself.
Who This Situation Fits and Who Should Think Differently
John’s profile is specific: high earner near retirement, a defined benefit pension providing guaranteed income, and a large pre-tax 401(k) balance. For someone in this position, delaying large withdrawals until after earned income stops is a straightforward approach. The pension provides a floor, and 401(k) withdrawals can be sized each year to fill the bracket efficiently without pushing into the next tier.
Someone without a pension faces a different calculus. If retirement income is entirely discretionary, large lump withdrawals create more bracket volatility. In that case, a Roth conversion strategy in the years before retirement can pre-pay taxes at a lower rate and provide tax-free flexibility later. John’s $25,000 Roth 401(k) balance suggests some familiarity with this structure, though the amount is small relative to his total savings.
His $30,000 HSA HSA adds another option. HSA funds can be withdrawn for any purpose after age 65 and are taxed as ordinary income, similar to a traditional IRA. That gives John another tax-managed bucket to draw from in smaller amounts without triggering a large bracket jump.
Key Tax Considerations for John’s Situation
Modeling retirement income carefully matters here. The pension at $9,500 per month is the baseline. Adding Social Security (which he has not yet claimed) on top of that may push him higher than expected before he takes a single dollar from the 401(k). Knowing exactly where he lands in the bracket structure before making withdrawals determines how much he owes.
Confirming with a tax professional that FICA does not apply to 401(k) distributions is also relevant. This is a foundational misunderstanding, and correcting it changes the effective cost estimate in a meaningful way. The tax owed is real, but it is ordinary income tax, not the payroll tax he referenced.
John mentions a Fidelity account with $4.6 million total. For assets held in a taxable brokerage account, gifting appreciated securities is a general strategy some donors use, as recipients may sell at their own capital gains rate rather than the donor first withdrawing cash and paying income tax on the full amount.
John owes ordinary federal income tax on 401(k) withdrawals, and sizing those withdrawals to stay within a lower bracket is the central planning question. Waiting until retirement to make those withdrawals, sizing them to stay within a manageable bracket, and examining whether taxable assets can carry part of the gift load are the three levers that factor most directly into the tax outcome here.
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